Is Depreciation an Operating Expense?

Depreciation is a non-cash operating expense, where the cost of a fixed asset is allocated to its useful life. It is reflected in the statement of profit and loss and reduces the income before tax.

Operating expenses are referred to as the expenses such as rent, salaries, and utilities that are incurred in the regular course of conducting business.

Depreciation is considered an operating expense because fixed assets generate income.

Depreciation is marked as an “expense” on the income statement that impacts a company’s finances.

Depreciation – An Operating Expense?

Depreciation involves reducing the value of fixed assets, which are essential for business operations. Even though depreciation expenses are recorded monthly, quarterly, or yearly, the assets are being used and consumed continuously.

So, depreciation is considered an operating expense because the assets it is depreciating are related to regular business operations.

Businesses normally purchase fixed assets for long-term use, and when a company acquires an asset, it has two options: it can either immediately deduct all direct costs during replacement or depreciate the entire value throughout the item’s useful life.

Companies prefer using the depreciation process because it reduces the initial cost of the asset and helps transfer the asset’s value from the balance sheet to the income statement. In this process, accumulated depreciation becomes a part of the business’s operating expenses.

Depreciation doesn’t have any outgoing cash flow.

Examples of When Depreciation is an Operating Expense

Depreciation is considered an “ operating expense” by the business when the fixed asset is depreciated and is used by the business for its main operational activity.

Depreciation is considered a “non-operating expense” by the business when the fixed assets are depreciated and are used by the business in an incidental activity.

Examples when the deprecation is considered as “operating expense”:

• Depreciation expenses are recorded for tangible assets utilized in the business owner’s sales and administrative departments. These costs are considered part of the SG&A expenses within the operating expenses.

• Depreciation of assets used in sales and administrative equipment, such as warehouse equipment and delivery trucks, is also included in operating expenses.

• Depreciation expense incurred on tangible assets that are directly involved in the manufacturing of goods. This expense is a direct allocation to the cost of goods sold and is typically the largest allocation on the business owner’s financial statement.

Is Depreciation Tax Deductible?

According to the IRS, depreciation is an income tax deduction that allows a taxpayer to recover the purchase price or a different basis for specific assets.

An asset used by a company to generate revenue is known as a fixed asset. When acquiring an asset of this type, the business owner does not anticipate selling it within a year; instead, the item will continue to be utilized for trade and commercial purposes and contribute to long-term revenue generation. Depreciation is also possible for residential real estate.

A few depreciable assets are:

• Machinery
• Buildings
• Furniture
• Computers and software
• Vehicles

Businesses have the option to choose the depreciation deduction method. They have the option of deducting the amount as depreciation or writing it off as an expense. A company can write off the entire cost as an expense in the first year or can write off the asset’s value throughout its useful life.

Conclusion

Depreciation is considered an operating expense in accounting, even though it is a non-cash item. By classifying depreciation as an operational expense, businesses can more accurately show their financial performance and reflect the ongoing costs of using and maintaining their assets.